31 January 2009

The Prime Minister takes my advice or is it that great minds think alike

I had some gratuitous? advice for the Ruddster...

"The Prime Minister needs to review the errors of Scullen, ditch the tawdry advice of those who "didn't see it coming" and get ready to bite the bullet and abandon, repudiate and punish those responsible for this long terrible sleepwalk into disaster: the property and real estate carny barkers, the directors of public companies unresponsive to the will of shareholders, the housing developers against local democracy, the auditors and accountants who certified an oligopoly of greed and tax fraud prudent in return for a place on the gravy train. And generally, the whole media, business and professional elite that apropriated twenty years of productivity growth on the promise of prosperity for all and delivered instead declining real incomes, insecurity of tenure and equal opportunity disaster."

open letter to PM

Well, I only caught the zeitgeist, I guess because Rudd's letter of thanks didn't arive.

But the news of his 180 degree turn is everywhere..

"In an essay to be published next week, the Prime Minister is scathing of the neo-liberals who began refashioning the market system in the 1970s, and ultimately brought about the global financial crisis.

"The time has come, off the back of the current crisis, to proclaim that the great neo-liberal experiment of the past 30 years has failed, that the emperor has no clothes," he writes of those who placed their faith in the corrective powers of the market.

"Neo-liberalism and the free-market fundamentalism it has produced has been revealed as little more than personal greed dressed up as an economic philosophy. And, ironically, it now falls to social democracy to prevent liberal capitalism from cannibalising itself."

Mr Rudd writes in The Monthly that just as Franklin Roosevelt rebuilt US capitalism after the Great Depression, modern-day "social democrats" such as himself and the US President, Barack Obama, must do the same again. But he argues that "minor tweakings of long-established orthodoxies will not do" and advocates a new system that reaches beyond the 70-year-old interventionist principles of John Maynard Keynes.

"A system of open markets, unambiguously regulated by an activist state, and one in which the state intervenes to reduce the greater inequalities that competitive markets will inevitably generate," he writes.

He urges "a new contract for the future that eschews the extremism of both the left and right".

He mocks neo-liberals "who now find themselves tied in ideological knots in being forced to rely on the state they fundamentally despise to save financial markets from collapse"."

rudd breaks off the dance

Academic scans former Master of Universe

I had dinner last night with a guy whose career wandered through nearly a half-dozen major brokerages. He was at ground zero of the securitization and creation of the alphabet soup of the real estate market. He ushered these new era inventions past the lawyers and regulators, launching them with the ringing endorsement "We don't see any legal reason why you cannot do that." He attained the level of CEO of a major banking subsidiary, until jumping ship a few years back as it became clear the game was over. He is still actively involved with the Fed trying to help sort out this mess.

I should first provide my impressions of the man. To some, this guy is Lord Voldemort. I was fully expecting to find him repugnant, arrogant, insufferable; I was prepared to either bite my lip bloody or do battle, whichever seemed more constructive. In a ping-pong-like exchange that spanned five hours, however, I found him remarkably endearing, humble, and contrite. Oddly enough, at no point did I find myself casting blame on him. Many of his actions--actions that were clearly extreme in retrospect--were shockingly understandable in context. In short, I really liked the guy. This will be hard to understand (and certainly draw scorn) based on what follows.

So what did I learn? Wall Street and the banking system is every bit as nuts as we all think. A bunch of twenty somethings with little or no adult supervision came up with ideas akin to extreme sports you see on Youtube. They did it because they could. You want leverage? Imagine a 20 billion dollar portfolio of mortgage backed securities with a capital base of $10k--literally 2 million-fold leverage. Imagine the shock of the inventor as he watches as his successors expand similar portfolios up to $900 billion. After running out of gullible Japanese bankers (and the Japanese were indeed pissed off before it was over) these young cowboys began trolling for other pools of gullible buyers: hedge funds, pension funds, and University endowments sufficed. They even found some local suckers. While sitting in a meeting listening to some guy within his own firm rant about some great tranche he just purchased for the firm, my dinner guest jumps up and blurts out, “That's the dogshit that we sold into the open market you idiot. You don't eat your own dogshit!� Squareds and cubes were described with the same level of astonishment that I was experiencing listening to the details.

How did we go so far off the tracks? He offered a few nuggets that seemed to explain the credit bubble. To reiterate, there really was no adult supervision. The guys putting these packages together certainly had some sense that they were crazy but nobody said stop. Government regulators being paid $100k couldn't tell guys making $20 million to take a hike. The senior managers loved the money flows. Cubicles--millions of cubicles--were staffed with engineers, chemists, physicists, and mathematicians from the best colleges in the country with no knowledge of the history of markets, fat tails, and past human follies, only how to finanically engineer.

Several critical mutations occurred over time:

(1) The average career age in the business is something like 7 years. A twenty year veteran is a very old man. The creators of these new-fangled products understood the toxicity at some level. As they retired, however, the next generation of twenty somethings had zero sense of risk. They were simply told which button to push and which lever to pull to make money. Nobody was driving the cab at all.

(2) The money overwhelmed the system. It was like when the computers gained consciousness in Terminator. The money pushed all regulations aside. It bought deregulation, politicians, and anything else necessary to keep the money machine growing. Nobody dared yell stop because so damned much money was being made.

(3) Greenspan became a believer--he lost consciousness. (This has some bias from me; the evils of AG were not refuted.) As to whether he understood what he was doing or knowingly let the scam run remained unanswered. (I personally suspect that arrogance and incompetence mixed toxically to produce a world-class dickhead.)

So where are we now, and where are we heading? This is the bad part: I thought I was the pessimist. Sheesh. He was describing a system infected by flesh eating bacteria. Every day looks more dire than the previous day. The solutions being proposed look feeble, and the Fed looks both powerless and confused. The good bank/bad bank model that lit up the market yesterday was suggested to be flawed because the good banks would turn bad soon thereafter. When asked about seemingly stable local banks, he suggested they too would become infected. I expressed shock that JPM not only didn't bring the system to its knees but was the last bank standing. That Jamie Dimon is quite a guy, eh? Apparently, I inferred from the answer (am nervous about explicitly attributing by quote) that JPM is on a don't ask/don't tell policy; the Fed simply cannot handle another mega-catastrophe while they wrestle with the fully-insolvent Citigroup and Bank of America. I suspect that JPM was told to keep everything looking peachy to buy time. (Maybe this was what caused the delayed reaction of Bank of America when it should have been gagging on its own vomit months ago.) Jack Welch got very low grades for engineering his balance sheet, moving to shorter duration debt to make GE profitable. The car industry is DOA. Germany and the UK are battling for the bottom rung of the sovereign ladder (above Iceland hopefully.) Why has the NYC housing market held up? Supposedly, it is only a matter of time: “New York may look like Detroit in ten years.� When peers claimed housing would bottom after a 40% drop, he asked “Why will it stop there?� No answer. Last but not least, the failed German bond auction was deemed catastropic: Who is gonna buy up our trillions? No answer.

In short, he sees no way out of this mess without serious pain. Despite a deflationary slant today, he sees inflation and spiking interest rates as the risk going forward. (I am short treasuries at a token level: Booyaa skidaddy!)

He finished on an upbeat note. He sermonized to my class, noting that the HR people at his last employer nicknamed the young employees the e-generation. What does the e stand for, they were asked? Entitlement! He urged the students to bust their asses, eat buckets of shit when necessary, and plan on working hard for a living. He reminded us that, by any measure, the US still has the resources and political system to dominate the globe. The healing will require retooling the workforce and educational system. The most critical part of the healing process may be a severe beating. Hard to argue with any of that if you ask me.

There you have it folks.

Chinese Premier Wen Jiabao speaks at the World Economic Forum

Annual meeting, in Davos, Switzerland, on Jan. 28, 2009.
(Xinhua/Yao Dawei) Strengthen Confidence and Work Together for A New Round of World Economic Growth

28 January 2009

Professor Klaus Schwab, Executive Chairman of the World Economic Forum, Ladies and Gentlemen,

I am delighted to be here and address the World Economic Forum Annual Meeting 2009. Let me begin by thanking Chairman Schwab for his kind invitation and thoughtful arrangements. This annual meeting has a special significance. Amidst a global financial crisis rarely seen in history, it brings together government leaders, business people, experts and scholars of different countries to jointly explore ways to maintain international financial stability, promote world economic growth and better address global issues. Its theme — “Shaping the Post-Crisis World” is highly relevant. It reflects the vision of its organizers. People from across the world are eager to hear words of wisdom from here that will give them strength to tide over the crisis. It is thus our responsibility to send to the world a message of confidence, courage and hope. I look forward to a successful meeting.

The ongoing international financial crisis has landed the world economy in the most difficult situation since last century’s Great Depression. In the face of the crisis, countries and the international community have taken various measures to address it. These measures have played an important role in boosting confidence, reducing the consequences of the crisis, and forestalling a meltdown of the financial system and a deep global recession. This crisis is attributable to a variety of factors and the major ones are: inappropriate macroeconomic policies of some economies and their unsustainable model of development characterized by prolonged low savings and high consumption; excessive expansion of financial institutions in a blind pursuit of profit; lack of self-discipline among financial institutions and rating agencies and the ensuing distortion of risk information and asset pricing; and the failure of financial supervision and regulation to keep up with financial innovations, which allowed the risks of financial derivatives to build and spread. As the saying goes, “A fall in the pit, a gain in your wit,” we must draw lessons from this crisis and address its root causes. In other words, we must strike a balance between savings and consumption, between financial innovation and regulation, and between the financial sector and real economy.


30 January 2009

The Gaza Bombshell ~ Vanity Fair

In the light of the article following, go back and re-examine supposed stupid errors - two wars, refusal to sign-on for preservation of the biosphere, corruption of the monetary system, corruption of the justice system. . . a consistent pattern of destruction of social structures [The US, Iraq, Afghanistan, Columbia] that might have contained and controlled damage.

You will find only the monomania called "Use of Weapons" - bombs, land-mines, missiles, bullets - but not more orderly or open societies.

Lets face it, the Bush years have been characterised by a rush to chaos and endlessly rising entropy.

On to Vanity Fair.

"After failing to anticipate Hamas’s victory over Fatah in the 2006 Palestinian election, the White House cooked up yet another scandalously covert and self-defeating Middle East debacle: part Iran-contra, part Bay of Pigs. With confidential documents, corroborated by outraged former and current U.S. officials, the author reveals how President Bush, Condoleezza Rice, and Deputy National-Security Adviser Elliott Abrams backed an armed force under Fatah strongman Muhammad Dahlan, touching off a bloody civil war in Gaza and leaving Hamas stronger than ever.

The Al Deira Hotel, in Gaza City, is a haven of calm in a land beset by poverty, fear, and violence. In the middle of December 2007, I sit in the hotel’s airy restaurant, its windows open to the Mediterranean, and listen to a slight, bearded man named Mazen Asad abu Dan describe the suffering he endured 11 months before at the hands of his fellow Palestinians. Abu Dan, 28, is a member of Hamas, the Iranian-backed Islamist organization that has been designated a terrorist group by the United States, but I have a good reason for taking him at his word: I’ve seen the video.

To hear an interview with David Rose and to see documents he uncovered, click here.

It shows abu Dan kneeling, his hands bound behind his back, and screaming as his captors pummel him with a black iron rod. “I lost all the skin on my back from the beatings,” he says. “Instead of medicine, they poured perfume on my wounds. It felt as if they had taken a sword to my injuries.”

On January 26, 2007, abu Dan, a student at the Islamic University of Gaza, had gone to a local cemetery with his father and five others to erect a headstone for his grandmother. When they arrived, however, they found themselves surrounded by 30 armed men from Hamas’s rival, Fatah, the party of Palestinian president Mahmoud Abbas. “They took us to a house in north Gaza,” abu Dan says. “They covered our eyes and took us to a room on the sixth floor.”

The video reveals a bare room with white walls and a black-and-white tiled floor, where abu Dan’s father is forced to sit and listen to his son’s shrieks of pain. Afterward, abu Dan says, he and two of the others were driven to a market square. “They told us they were going to kill us. They made us sit on the ground.” He rolls up the legs of his trousers to display the circular scars that are evidence of what happened next: “They shot our knees and feet—five bullets each. I spent four months in a wheelchair.”

Abu Dan had no way of knowing it, but his tormentors had a secret ally: the administration of President George W. Bush.

A clue comes toward the end of the video, which was found in a Fatah security building by Hamas fighters last June. Still bound and blindfolded, the prisoners are made to echo a rhythmic chant yelled by one of their captors: “By blood, by soul, we sacrifice ourselves for Muhammad Dahlan! Long live Muhammad Dahlan!”

There is no one more hated among Hamas members than Muhammad Dahlan, long Fatah’s resident strongman in Gaza. Dahlan, who most recently served as Abbas’s national-security adviser, has spent more than a decade battling Hamas. Dahlan insists that abu Dan was tortured without his knowledge, but the video is proof that his followers’ methods can be brutal.

Bush has met Dahlan on at least three occasions. After talks at the White House in July 2003, Bush publicly praised Dahlan as “a good, solid leader.” In private, say multiple Israeli and American officials, the U.S. president described him as “our guy.”

he United States has been involved in the affairs of the Palestinian territories since the Six-Day War of 1967, when Israel captured Gaza from Egypt and the West Bank from Jordan. With the 1993 Oslo accords, the territories acquired limited autonomy, under a president, who has executive powers, and an elected parliament. Israel retains a large military presence in the West Bank, but it withdrew from Gaza in 2005.

In recent months, President Bush has repeatedly stated that the last great ambition of his presidency is to broker a deal that would create a viable Palestinian state and bring peace to the Holy Land. “People say, ‘Do you think it’s possible, during your presidency?’ ” he told an audience in Jerusalem on January 9. “And the answer is: I’m very hopeful.”

The next day, in the West Bank capital of Ramallah, Bush acknowledged that there was a rather large obstacle standing in the way of this goal: Hamas’s complete control of Gaza, home to some 1.5 million Palestinians, where it seized power in a bloody coup d’état in June 2007. Almost every day, militants fire rockets from Gaza into neighboring Israeli towns, and President Abbas is powerless to stop them. His authority is limited to the West Bank.

It’s “a tough situation,” Bush admitted. “I don’t know whether you can solve it in a year or not.” What Bush neglected to mention was his own role in creating this mess.

According to Dahlan, it was Bush who had pushed legislative elections in the Palestinian territories in January 2006, despite warnings that Fatah was not ready. After Hamas—whose 1988 charter committed it to the goal of driving Israel into the sea—won control of the parliament, Bush made another, deadlier miscalculation.

Vanity Fair has obtained confidential documents, since corroborated by sources in the U.S. and Palestine, which lay bare a covert initiative, approved by Bush and implemented by Secretary of State Condoleezza Rice and Deputy National Security Adviser Elliott Abrams, to provoke a Palestinian civil war. The plan was for forces led by Dahlan, and armed with new weapons supplied at America’s behest, to give Fatah the muscle it needed to remove the democratically elected Hamas-led government from power. (The State Department declined to comment.)

But the secret plan backfired, resulting in a further setback for American foreign policy under Bush. Instead of driving its enemies out of power, the U.S.-backed Fatah fighters inadvertently provoked Hamas to seize total control of Gaza.

Some sources call the scheme “Iran-contra 2.0,” recalling that Abrams was convicted (and later pardoned) for withholding information from Congress during the original Iran-contra scandal under President Reagan. There are echoes of other past misadventures as well: the C.I.A.’s 1953 ouster of an elected prime minister in Iran, which set the stage for the 1979 Islamic revolution there; the aborted 1961 Bay of Pigs invasion, which gave Fidel Castro an excuse to solidify his hold on Cuba; and the contemporary tragedy in Iraq.

Within the Bush administration, the Palestinian policy set off a furious debate. One of its critics is David Wurmser, the avowed neoconservative, who resigned as Vice President Dick Cheney’s chief Middle East adviser in July 2007, a month after the Gaza coup.

Wurmser accuses the Bush administration of “engaging in a dirty war in an effort to provide a corrupt dictatorship [led by Abbas] with victory.” He believes that Hamas had no intention of taking Gaza until Fatah forced its hand. “It looks to me that what happened wasn’t so much a coup by Hamas but an attempted coup by Fatah that was pre-empted before it could happen,” Wurmser says.

The botched plan has rendered the dream of Middle East peace more remote than ever, but what really galls neocons such as Wurmser is the hypocrisy it exposed. “There is a stunning disconnect between the president’s call for Middle East democracy and this policy,” he says. “It directly contradicts it.”
Its here

"Bonus's Shamefull" Obama says

NEW YORK (MarketWatch) - President Barack Obama blasted Wall Street on Thursday for shameful and irresponsible behavior after reports that Wall Street paid $18.4 billion in bonuses in 2008, even as the industry collapsed, costing taxpayers billions of dollars and tens of thousand of job cuts.
Despite the collapse of the financial system, the shuttering of several major firms and the elimination of thousands of jobs, the securities industry managed to scratch together about $18 billion of shareholder and investor cash to pay bonuses in 2008, according to New York state comptroller Thomas DiNapoli.
"The decline is the largest on record in absolute dollars and the largest percentage decline in more than 30 years, but the size of the bonus pool is still the sixth largest on record," DiNapoli said in a press release. See press release. See bonus data since 1985.
"...that is the height of irresponsibility. It is shameful," Obama said in an exchange with reporters Thursday afternoon.
The New York state comptroller's office said late Wednesday that total Wall Street bonuses paid fell 44% in 2008, to $18.4 billion, while the average bonus fell 36.7%, to $112,020.

'It's painfully obvious that 2009 will probably be another difficult year for the industry.'

— Thomas DiNapoli, New York state comptroller
Total bonuses paid in 2007 were $32.9 billion, and the average last year was $177,010.
The decline in the average bonus was smaller than the decline in the bonus pool because the pool was shared among fewer workers as the industry shed jobs, according to a press release from DiNapoli's office.
Obama was clearly disturbed by news of the bonuses.
"There will be time for them to make profits, and there will be time for them to get bonuses -- now is not that time. And that's a message that I intend to send directly to them, I expect Secretary Geithner to send to them -- and Secretary Geithner already had to pull back one institution that had gone forward with a multimillion dollar jet plane purchase at the same time as they're receiving TARP money," the president said.
"We shouldn't have to do that because they should know better. And we will continue to send that message loud and clear," Obama concluded.
Employment in the securities industry in New York City declined from 187,800 in October 2007 to 168,600 in December 2008, a loss of 19,200 jobs, or 10.2%, the agency reported.
The decline in the bonus pool "will ripple through the regional economy and the state and the city will lose major tax revenues," DiNapoli said.
"The securities industry has already lost tens of thousands of jobs and the industry is still continuing to write off toxic assets. It's painfully obvious that 2009 will probably be another difficult year for the industry."
The comptroller also estimated that losses incurred by the traditional securities broker/dealer businesses of the New York Stock Exchange's member firms totaled more than $35 billion in 2008 -- more than triple the previous record loss, which he said was posted in 2007.
However, to keep those figures in perspective, the comptroller's office said that those losses earned the firms as a whole a $31.3 billion tax credit and that this "will reduce the firms' future tax payments for years to come."

Planes, Ships and Trucks stop moving stuff

ARLINGTON, VA — The American Trucking Associations’ advanced seasonally adjusted For-Hire Truck Tonnage Index plunged 11.1 percent in December 2008, marking the largest month-to-month reduction since April 1994, when the unionized less-than-truckload industry was in the midst of a strike. December’s drop was the third-largest single-month drop since ATA began collecting the data in 1973. In December, the seasonally adjusted tonnage index equaled just 98.3 (2000 = 100), its lowest level since December 2000. The not seasonally adjusted index edged 0.6 percent higher in December.

Compared with December 2007, the index declined 14.1 percent, the biggest year-over-year decrease since February 1996. During the fourth quarter, tonnage was down 6.0 percent from the same quarter in 2007.....

The Baltic Dry Index, which measures drybulk shipping rates, dropped by 94 percent from May to December as commodity prices sank and the credit crisis took hold.

"The 22.6% free fall in global cargo is unprecedented and shocking. There is no clearer description of the slowdown in world trade. Even in September 2001, when much of the global fleet was grounded, the decline was only 13.9%,� said Giovanni Bisignani, IATA's Director General and CEO.� Air cargo carries 35% of the value of goods traded internationally.

The Big Fix ~ NYT

February 1, 2009
Magazine Preview
The Big Fix


The economy will recover. It won’t recover anytime soon. It is likely to get significantly worse over the course of 2009, no matter what President Obama and Congress do. And resolving the financial crisis will require both aggressiveness and creativity. In fact, the main lesson from other crises of the past century is that governments tend to err on the side of too much caution — of taking the punch bowl away before the party has truly started up again. “The mistake the United States made during the Depression and the Japanese made during the ’90s was too much start-stop in their policies,” said Timothy Geithner, Obama’s choice for Treasury secretary, when I went to visit him in his transition office a few weeks ago. Japan announced stimulus measures even as it was cutting other government spending. Franklin Roosevelt flirted with fiscal discipline midway through the New Deal, and the country slipped back into decline.

Geithner arguably made a similar miscalculation himself last year as a top Federal Reserve official who was part of a team that allowed Lehman Brothers to fail. But he insisted that the Obama administration had learned history’s lesson. “We’re just not going to make that mistake,” Geithner said. “We’re not going to do that. We’ll keep at it until it’s done, whatever it takes.”

Once governments finally decide to use the enormous resources at their disposal, they have typically been able to shock an economy back to life. They can put to work the people, money and equipment sitting idle, until the private sector is willing to begin using them again. The prescription developed almost a century ago by John Maynard Keynes does appear to work.

But while Washington has been preoccupied with stimulus and bailouts, another, equally important issue has received far less attention — and the resolution of it is far more uncertain. What will happen once the paddles have been applied and the economy’s heart starts beating again? How should the new American economy be remade? Above all, how fast will it grow?

That last question may sound abstract, even technical, compared with the current crisis. Yet the consequences of a country’s growth rate are not abstract at all. Slow growth makes almost all problems worse. Fast growth helps solve them. As Paul Romer, an economist at Stanford University, has said, the choices that determine a country’s growth rate “dwarf all other economic-policy concerns.”

Growth is the only way for a government to pay off its debts in a relatively quick and painless fashion, allowing tax revenues to increase without tax rates having to rise. That is essentially what happened in the years after World War II. When the war ended, the federal government’s debt equaled 120 percent of the gross domestic product (more than twice as high as its likely level by the end of next year). The rapid economic growth of the 1950s and ’60s — more than 4 percent a year, compared with 2.5 percent in this decade — quickly whittled that debt away. Over the coming 25 years, if growth could be lifted by just one-tenth of a percentage point a year, the extra tax revenue would completely pay for an $800 billion stimulus package.

Yet there are real concerns that the United States’ economy won’t grow enough to pay off its debts easily and ensure rising living standards, as happened in the postwar decades. The fraternity of growth experts in the economics profession predicts that the economy, on its current path, will grow more slowly in the next couple of decades than over the past couple. They are concerned in part because two of the economy’s most powerful recent engines have been exposed as a mirage: the explosion in consumer debt and spending, which lifted short-term growth at the expense of future growth, and the great Wall Street boom, which depended partly on activities that had very little real value.

Richard Freeman, a Harvard economist, argues that our bubble economy had something in common with the old Soviet economy. The Soviet Union’s growth was artificially raised by massive industrial output that ended up having little use. Ours was artificially raised by mortgage-backed securities, collateralized debt obligations and even the occasional Ponzi scheme.

Where will new, real sources of growth come from? Wall Street is not likely to cure the nation’s economic problems. Neither, obviously, is Detroit. Nor is Silicon Valley, at least not by itself. Well before the housing bubble burst, the big productivity gains brought about by the 1990s technology boom seemed to be petering out, which suggests that the Internet may not be able to fuel decades of economic growth in the way that the industrial inventions of the early 20th century did. Annual economic growth in the current decade, even excluding the dismal contributions that 2008 and 2009 will make to the average, has been the slowest of any decade since the 1930s.

So for the first time in more than 70 years, the epicenter of the American economy can be placed outside of California or New York or the industrial Midwest. It can be placed in Washington. Washington won’t merely be given the task of pulling the economy out of the immediate crisis. It will also have to figure out how to put the American economy on a more sustainable path — to help it achieve fast, broadly shared growth and do so without the benefit of a bubble. Obama said as much in his inauguration speech when he pledged to overhaul Washington’s approach to education, health care, science and infrastructure, all in an effort to “lay a new foundation for growth.”

For centuries, people have worried that economic growth had limits — that the only way for one group to prosper was at the expense of another. The pessimists, from Malthus and the Luddites and on, have been proved wrong again and again. Growth is not finite. But it is also not inevitable. It requires a strategy.


TWO WEEKS AFTER THE ELECTION, Rahm Emanuel, Obama’s chief of staff, appeared before an audience of business executives and laid out an idea that Lawrence H. Summers, Obama’s top economic adviser, later described to me as Rahm’s Doctrine. “You never want a serious crisis to go to waste,” Emanuel said. “What I mean by that is that it’s an opportunity to do things you could not do before.”

In part, the idea is standard political maneuvering. Obama had an ambitious agenda — on health care, energy and taxes — before the economy took a turn for the worse in the fall, and he has an interest in connecting the financial crisis to his pre-existing plans. “Things we had postponed for too long, that were long term, are now immediate and must be dealt with,” Emanuel said in November. Of course, the existence of the crisis doesn’t force the Obama administration to deal with education or health care. But the fact that the economy appears to be mired in its worst recession in a generation may well allow the administration to confront problems that have festered for years. That’s the crux of the doctrine.

The counterargument is hardly trivial — namely, that the financial crisis is so serious that the administration shouldn’t distract itself with other matters. That is a risk, as is the additional piling on of debt for investments that might not bear fruit for a long while. But Obama may not have the luxury of trying to deal with the problems separately. This crisis may be his one chance to begin transforming the economy and avoid future crises.

In the early 1980s, an economist named Mancur Olson developed a theory that could fairly be called the academic version of Rahm’s Doctrine. Olson, a University of Maryland professor who died in 1998, is one of those academics little known to the public but famous among his peers. His seminal work, “The Rise and Decline of Nations,” published in 1982, helped explain how stable, affluent societies tend to get in trouble. The book turns out to be a surprisingly useful guide to the current crisis.

In Olson’s telling, successful countries give rise to interest groups that accumulate more and more influence over time. Eventually, the groups become powerful enough to win government favors, in the form of new laws or friendly regulators. These favors allow the groups to benefit at the expense of everyone else; not only do they end up with a larger piece of the economy’s pie, but they do so in a way that keeps the pie from growing as much as it otherwise would. Trade barriers and tariffs are the classic example. They help the domestic manufacturer of a product at the expense of millions of consumers, who must pay high prices and choose from a limited selection of goods.

Olson’s book was short but sprawling, touching on everything from the Great Depression to the caste system in India. His primary case study was Great Britain in the decades after World War II. As an economic and military giant for more than two centuries, it had accumulated one of history’s great collections of interest groups — miners, financial traders and farmers, among others. These interest groups had so shackled Great Britain’s economy by the 1970s that its high unemployment and slow growth came to be known as “British disease.”

Germany and Japan, on the other hand, were forced to rebuild their economies and political systems after the war. Their interest groups were wiped away by the defeat. “In a crisis, there is an opportunity to rearrange things, because the status quo is blown up,” Frank Levy, an M.I.T. economist and an Olson admirer, told me recently. If a country slowly glides down toward irrelevance, he said, the constituency for reform won’t take shape. Olson’s insight was that the defeated countries of World War II didn’t rise in spite of crisis. They rose because of it.

The parallels to the modern-day United States, though not exact, are plain enough. This country’s long period of economic pre-eminence has produced a set of interest groups that, in Olson’s words, “reduce efficiency and aggregate income.” Home builders and real estate agents pushed for housing subsidies, which made many of them rich but made the real estate bubble possible. Doctors, drug makers and other medical companies persuaded the federal government to pay for expensive treatments that have scant evidence of being effective. Those treatments are the primary reason this country spends so much more than any other on medicine. In these cases, and in others, interest groups successfully lobbied for actions that benefited them and hurt the larger economy.

Surely no interest group fits Olson’s thesis as well as Wall Street. It used an enormous amount of leverage — debt — to grow to unprecedented size. At times Wall Street seemed ubiquitous. Eight Major League ballparks are named for financial-services companies, as are the theater for the Alvin Ailey dance company, a top children’s hospital in New York and even a planned entrance of the St. Louis Zoo. At Princeton, the financial-engineering program, meant to educate future titans of finance, enrolled more undergraduates than any of the traditional engineering programs. Before the stock market crashed last year, finance companies earned 27 percent of the nation’s corporate profits, up from about 15 percent in the 1970s and ’80s. These profits bought political influence. Congress taxed the income of hedge-fund managers at a lower rate than most everyone else’s. Regulators didn’t ask too many hard questions and then often moved on to a Wall Street job of their own.

In good times — or good-enough times — the political will to beat back such policies simply doesn’t exist. Their costs are too diffuse, and their benefits too concentrated. A crisis changes the dynamic. It’s an opportunity to do things you could not do before.

England’s crisis was the Winter of Discontent, in 1978-79, when strikes paralyzed the country and many public services shut down. The resulting furor helped elect Margaret Thatcher as prime minister and allowed her to sweep away some of the old economic order. Her laissez-faire reforms were flawed in some important ways — taken to an extreme, they helped create the current financial crisis — and they weren’t the only reason for England’s turnaround. But they made a difference. In the 30 years since her election, England has grown faster than Germany or Japan.


ONE GOOD WAY TO UNDERSTAND the current growth slowdown is to think of the debt-fueled consumer-spending spree of the past 20 years as a symbol of an even larger problem. As a country we have been spending too much on the present and not enough on the future. We have been consuming rather than investing. We’re suffering from investment-deficit disorder.

You can find examples of this disorder in just about any realm of American life. Walk into a doctor’s office and you will be asked to fill out a long form with the most basic kinds of information that you have provided dozens of times before. Walk into a doctor’s office in many other rich countries and that information — as well as your medical history — will be stored in computers. These electronic records not only reduce hassle; they also reduce medical errors. Americans cannot avail themselves of this innovation despite the fact that the United States spends far more on health care, per person, than any other country. We are spending our money to consume medical treatments, many of which have only marginal health benefits, rather than to invest it in ways that would eventually have far broader benefits.

Along similar lines, Americans are indefatigable buyers of consumer electronics, yet a smaller share of households in the United States has broadband Internet service than in Canada, Japan, Britain, South Korea and about a dozen other countries. Then there’s education: this country once led the world in educational attainment by a wide margin. It no longer does. And transportation: a trip from Boston to Washington, on the fastest train in this country, takes six-and-a-half hours. A trip from Paris to Marseilles, roughly the same distance, takes three hours — a result of the French government’s commitment to infrastructure.

These are only a few examples. Tucked away in the many statistical tables at the Commerce Department are numbers on how much the government and the private sector spend on investment and research — on highways, software, medical research and other things likely to yield future benefits. Spending by the private sector hasn’t changed much over time. It was equal to 17 percent of G.D.P. 50 years ago, and it is about 17 percent now. But spending by the government — federal, state and local — has changed. It has dropped from about 7 percent of G.D.P. in the 1950s to about 4 percent now.

Governments have a unique role to play in making investments for two main reasons. Some activities, like mass transportation and pollution reduction, have societal benefits but not necessarily financial ones, and the private sector simply won’t undertake them. And while many other kinds of investments do bring big financial returns, only a fraction of those returns go to the original investor. This makes the private sector reluctant to jump in. As a result, economists say that the private sector tends to spend less on research and investment than is economically ideal.

Historically, the government has stepped into the void. It helped create new industries with its investments. Economic growth has many causes, including demographics and some forces that economists admit they don’t understand. But government investment seems to have one of the best track records of lifting growth. In the 1950s and ’60s, the G.I. Bill created a generation of college graduates, while the Interstate System of highways made the entire economy more productive. Later, the Defense Department developed the Internet, which spawned AOL, Google and the rest. The late ’90s Internet boom was the only sustained period in the last 35 years when the economy grew at 4 percent a year. It was also the only time in the past 35 years when the incomes of the poor and the middle class rose at a healthy pace. Growth doesn’t ensure rising living standards for everyone, but it sure helps.

Even so, the idea that the government would be playing a much larger role in promoting economic growth would have sounded radical, even among Democrats, until just a few months ago. After all, the European countries that have tried guiding huge swaths of their economies — that have kept their arms around the “commanding heights,” in Lenin’s enduring phrase — have grown even more slowly than this country in recent years. But the credit crunch and the deepening recession have changed the discussion here. The federal government seems as if it was doing too little to take advantage of the American economy’s enormous assets: its size, its openness and its mobile, risk-taking work force. The government is also one of the few large entities today able to borrow at a low interest rate. It alone can raise the capital that could transform the economy in the kind of fundamental ways that Olson described.

“This recession is a critical economic problem — it is a crisis,” Summers told me recently. “But a moment when there are millions of people who are unemployed, when the federal government can borrow money over the long term at under 3 percent and when we face long-run fiscal problems is also a moment of great opportunity to make investments in the future of the country that have lagged for a long time.”

He then told a story that John F. Kennedy liked to tell, about an early-20th-century French marshal named Hubert Lyautey. “The guy says to his gardener, ‘Could you plant a tree?’ ” Summers said. “The gardener says, ‘Come on, it’s going to take 50 years before you see anything out of that tree.’ The guy says, ‘It’s going to take 50 years? Really? Then plant it this morning.’ ”


THE OBAMA ADMINISTRATION’S FIRST CHANCE to build a new economy — an investment economy — is the stimulus package that has been dominating policy discussions in Washington. Obama has repeatedly said he wants it to be a down payment on solving bigger problems. The twin goals, he said recently, are to “immediately jump-start job creation and long-term growth.” But it is not easy to balance those goals.

For the bill to provide effective stimulus, it simply has to spend money — quickly. Employing people to dig ditches and fill them up again would qualify. So would any of the “shovel ready” projects that have made it onto the list of stimulus possibilities. Even the construction of a mob museum in Las Vegas, a project that was crossed off the list after Republicans mocked it, would work to stimulate the economy, so long as ground was broken soon. Pork and stimulus aren’t mutually exclusive. But pork won’t transform an economy. Neither will the tax cuts that are likely to be in the plan.

Sometimes a project can give an economy a lift and also lead to transformation, but sometimes the goals are at odds, at least in the short term. Nothing demonstrates this quandary quite so well as green jobs, which are often cited as the single best hope for driving the post-bubble economy. Obama himself makes this case. Consumer spending has been the economic engine of the past two decades, he has said. Alternative energy will supposedly be the engine of the future — a way to save the planet, reduce the amount of money flowing to hostile oil-producing countries and revive the American economy, all at once. Put in these terms, green jobs sounds like a free lunch.

Green jobs can certainly provide stimulus. Obama’s proposal includes subsidies for companies that make wind turbines, solar power and other alternative energy sources, and these subsidies will create some jobs. But the subsidies will not be nearly enough to eliminate the gap between the cost of dirty, carbon-based energy and clean energy. Dirty-energy sources — oil, gas and coal — are cheap. That’s why we have become so dependent on them.

The only way to create huge numbers of clean-energy jobs would be to raise the cost of dirty-energy sources, as Obama’s proposed cap-and-trade carbon-reduction program would do, to make them more expensive than clean energy. This is where the green-jobs dream gets complicated.

For starters, of the $700 billion we spend each year on energy, more than half stays inside this country. It goes to coal companies or utilities here, not to Iran or Russia. If we begin to use less electricity, those utilities will cut jobs. Just as important, the current, relatively low price of energy allows other companies — manufacturers, retailers, even white-collar enterprises — to sell all sorts of things at a profit. Raising that cost would raise the cost of almost everything that businesses do. Some projects that would have been profitable to Boeing, Kroger or Microsoft in the current economy no longer will be. Jobs that would otherwise have been created won’t be. As Rob Stavins, a leading environmental economist, says, “Green jobs will, to some degree, displace other jobs.” Just think about what happened when gas prices began soaring last spring: sales of some hybrids increased, but vehicle sales fell overall.

None of this means that Obama’s climate policy is a mistake. Raising the price of carbon makes urgent sense, for the well-being of the planet and of the human race. And the economic costs of a serious climate policy are unlikely to be nearly as big as the alarmists — lobbyists and members of Congress trying to protect old-line energy industries — suggest. Various analyses of Obama’s cap-and-trade plan, including one by Stavins, suggest that after it is fully implemented, it would cost less than 1 percent of gross domestic product a year, or about $100 billion in today’s terms. That cost is entirely manageable. But it’s still a cost.

Or perhaps we should think of it as an investment. Like so much in the economy, our energy policy has been geared toward the short term. Inexpensive energy made daily life easier and less expensive for all of us. Building a green economy, on the other hand, will require some sacrifice. In the end, that sacrifice should pay a handsome return in the form of icecaps that don’t melt and droughts that don’t happen — events with costs of their own. Over time, the direct economic costs of a new energy policy may also fall. A cap-and-trade program will create incentives for the private sector to invest in alternative energy, which will lead to innovations and lower prices. Some of the new clean-energy spending, meanwhile, really will replace money now flowing overseas and create jobs here.

But all those benefits will come later. The costs will come sooner, which is a big reason we do not already have a green economy — or an investment economy.


WASHINGTON’S CHALLENGE on energy policy is to rewrite the rules so that the private sector can start building one of tomorrow’s big industries. On health care, the challenge is keeping one of tomorrow’s industries from growing too large.

For almost two decades, spending on health care grew rapidly, no matter what the rest of the economy was doing. Some of this is only natural. As a society gets richer and the basic comforts of life become commonplace, people will choose to spend more of their money on health and longevity instead of a third car or a fourth television.

Much of the increases in health care spending, however, are a result of government rules that have made the sector a fabulously — some say uniquely — inefficient sector. These inefficiencies have left the United States spending far more than other countries on medicine and, by many measures, getting worse results. The costs of health care are now so large that it has become one problem that cannot be solved by growth alone. It’s qualitatively different from the other budget problems facing the government, like the Wall Street bailout, the stimulus, the war in Iraq or Social Security.

You can see that by looking at various costs as a share of one year of economic output — that is, gross domestic product. Surprisingly, the debt that the federal government has already accumulated doesn’t present much of a problem. It is equal to about $6 trillion, or 40 percent of G.D.P., a level that is slightly lower than the average of the past six decades. The bailout, the stimulus and the rest of the deficits over the next two years will probably add about 15 percent of G.D.P. to the debt. That will take debt to almost 60 percent, which is above its long-term average but well below the levels of the 1950s. But the unfinanced parts of Medicare, the spending that the government has promised over and above the taxes it will collect in the coming decades requires another decimal place. They are equal to more than 200 percent of current G.D.P.

During the campaign, Obama talked about the need to control medical costs and mentioned a few ideas for doing so, but he rarely lingered on the topic. He spent more time talking about expanding health-insurance coverage, which would raise the government’s bill. After the election, however, when time came to name a budget director, Obama sent a different message. He appointed Peter Orszag, who over the last two years has become one of the country’s leading experts on the looming budget mess that is health care.

Orszag is a tall, 40-year-old Massachusetts native, made taller by his preference for cowboy boots, who has risen through the Democratic policy ranks over the last 15 years. He received a Ph.D. from the London School of Economics, later joined the Clinton White House and, from 2007, was the director of the Congressional Budget Office. While there, he devoted himself to studying health care, believing that it was far more important to the future of the budget than any other issue in front of Congress. He nearly doubled the number of health care analysts in the office, to 50. Obama highlighted this work when he announced Orszag’s appointment in November.

In Orszag’s final months on Capitol Hill, he specifically argued that health care reform should not wait until the financial system has been fixed. “One of the blessings in the current environment is that we have significant capacity to expand and sell Treasury debt,” he told me recently. “If we didn’t have that, and if the financial markets didn’t have confidence that we would repay that debt, we would be in even more dire straits than we are.” Absent a health care overhaul, the federal government’s lenders around the world may eventually grow nervous about its ability to repay its debts. That, in turn, will cause them to demand higher interest rates to cover their risk when lending to the United States. Facing higher interest rates, the government won’t be able to afford the kind of loans needed to respond to a future crisis, be it financial or military. The higher rates will also depress economic growth, aggravating every other problem.

So what should be done? Orszag was technically prohibited from advocating policies in his old job. But it wasn’t very hard to read between the lines. In a series of speeches around the country, in testimony to Congress and in a blog that he started (“Director’s Blog”), he laid out a fairly clear agenda.

Orszag would begin his talks by explaining that the problem is not one of demographics but one of medicine. “It’s not primarily that we’re going to have more 85-year-olds,” he said during a September speech in California. “It’s primarily that each 85-year-old in the future will cost us a lot more than they cost us today.” The medical system will keep coming up with expensive new treatments, and Medicare will keep reimbursing them, even if they bring little benefit.

After this introduction, Orszag would typically pause and advise his audience not to get too depressed. He would put a map of the United States on the screen behind him, showing Medicare spending by region. The higher-spending regions were shaded darker than the lower-spending regions. Orszag would then explain that the variation cannot be explained by the health of the local population or the quality of care it receives. Darker areas didn’t necessarily have sicker residents than lighter areas, nor did those residents necessarily receive better care. So, Orszag suggested, the goal of reform doesn’t need to be remaking the American health care system in the image of, say, the Dutch system. The goal seems more attainable than that. It is remaking the system of a high-spending place, like southern New Jersey or Texas, in the image of a low-spending place, like Minnesota, New Mexico or Virginia.

To that end, Orszag has become intrigued by the work of Mitchell Seltzer, a hospital consultant in central New Jersey. Seltzer has collected large amounts of data from his clients on how various doctors treat patients, and his numbers present a very similar picture to the regional data. Seltzer told me that big-spending doctors typically explain their treatment by insisting they have sicker patients than their colleagues. In response he has made charts breaking down the costs of care into thin diagnostic categories, like “respiratory-system diagnosis with ventilator support, severity: 4,” in order to compare doctors who were treating the same ailment. The charts make the point clearly. Doctors who spent more — on extra tests or high-tech treatments, for instance — didn’t get better results than their more conservative colleagues. In many cases, patients of the aggressive doctors stay sicker longer and die sooner because of the risks that come with invasive care.

The first step toward turning “less efficient” doctors, in Seltzer’s euphemism, into “efficient” doctors would be relatively uncontroversial. The government would have to create a national version of his database and, to do so, would need doctors and hospitals to have electronic medical records. The Obama administration plans to use the stimulus bill to help pay for the installation of such systems. It is then likely to mandate that, within five years, any doctor or hospital receiving Medicare payment must be using electronic records.

The next steps will be harder. Based on what the data show, Medicare will have to stop reimbursing some expensive treatments that don’t do much good. Private insurers would likely follow Medicare’s lead, as they have on other issues in the past. Doctors, many of whom make good money from extra treatments, are sure to object, just as Mancur Olson would have predicted. They will claim that, whatever the data show, the treatments are benefiting their patients. In a few cases — though, by definition, not most — they may be right. Even when they are not, their patients, desperate for hope, may fight for the treatment.

The most pessimistic point that Orszag routinely made during his time on Capitol Hill was that the political system didn’t deal well with simmering, long-term problems. It often waited until those problems became a crisis, he would say. That may be a kind of corollary to Rahm’s Doctrine, but it does highlight the task before the Obama administration. It will need to figure out how it can use one crisis as an excuse to prevent several more.


A GREAT APPEAL of green jobs — or, for that matter, of a growing and efficient health care sector — is that they make it possible to imagine what tomorrow’s economy might look like. They are concrete. When somebody wonders, What will replace Wall Street? What will replace housing? they can be given an answer.

As answers go, green jobs and health care are fine. But they probably aren’t the best answers. The best one is less concrete. It also has a lot more historical evidence on its side.

Last year, two labor economists, Claudia Goldin and Lawrence Katz, published a book called “The Race Between Education and Technology.” It is as much a work of history — the history of education — as it is a work of economics. Goldin and Katz set out to answer the question of how much an education really matters. They are themselves products of public schools, she of New York and he of Los Angeles, and they have been a couple for two decades. They are liberals (Katz served as the chief economist under Robert Reich in Bill Clinton’s Labor Department), but their book has been praised by both the right and the left. “I read the Katz and Goldin book,” Matthew Slaughter, an associate dean of Dartmouth’s business school who was an economic adviser to George W. Bush, recently told me, “and there’s part of me that can’t fathom that half the presidential debates weren’t about a couple of facts in that book.” Summers wrote a blurb for the book, calling it “the definitive treatment” of income inequality.

The book’s central fact is that the United States has lost its once-wide lead in educational attainment. South Korea and Denmark graduate a larger share of their population from college — and Australia, Japan and the United Kingdom are close on our heels.

Goldin and Katz explain that the original purpose of American education was political, to educate the citizens of a democracy. By the start of the 20th century, though, the purpose had become blatantly economic. As parents saw that high-school graduates were getting most of the good jobs, they started a grass-roots movement, known as the high-school movement, to demand free, public high schools in their communities. “Middletown,” the classic 1929 sociological study of life in Indiana, reported that education “evokes the fervor of a religion, a means of salvation, among a large section of the population.”

At the time, some European intellectuals dismissed the new American high schools as wasteful. Instead of offering narrowly tailored apprentice programs, the United States was accused of overeducating its masses (or at least its white masses). But Goldin and Katz, digging into old population surveys, show that the American system paid huge dividends. High-school graduates filled the ranks of companies like General Electric and John Deere and used their broad base of skills to help their employers become global powers. And these new white-collar workers weren’t the only ones to benefit. A high-school education also paid off for blue-collar workers. Those with a diploma were far more likely to enter newer, better-paying, more technologically advanced industries. They became plumbers, jewelers, electricians, auto mechanics and railroad engineers.

Not only did mass education increase the size of the nation’s economic pie; it also evened out the distribution. The spread of high schools — by 1940, half of teenagers were getting a diploma — meant that graduates were no longer an elite group. In economic terms, their supply had increased, which meant that the wage premium that came with a diploma was now spread among a larger group of workers. Sure enough, inequality fell rapidly in the middle decades of the 20th century.

But then the great education boom petered out, starting in the late 1960s. The country’s worst high schools never got their graduation rates close to 100 percent, while many of the fast-growing community colleges and public colleges, which were educating middle-class and poorer students, had low graduation rates. Between the early 1950s and early ’80s, the share of young adults receiving a bachelor’s degree jumped to 24 percent, from 7 percent. In the 30 years since, the share has only risen to 32 percent. Nearly all of the recent gains have come among women. For the first time on record, young men in the last couple of decades haven’t been much more educated than their fathers were.

Goldin and Katz are careful to say that economic growth is not simply a matter of investing in education. And we can all name exceptions to the general rule. Bill Gates dropped out of college (though, as Malcolm Gladwell explains in his recent book, “Outliers,” Gates received a fabulously intense computer-programming education while in high school). Some college graduates struggle to make a good living, and many will lose their jobs in this recession. But these are exceptions. Goldin’s and Katz’s thesis is that the 20th century was the American century in large part because this country led the world in education. The last 30 years, when educational gains slowed markedly, have been years of slower growth and rising inequality.

Their argument happens to be supported by a rich body of economic literature that didn’t even make it into the book. More-educated people are healthier, live longer and, of course, make more money. Countries that educate more of their citizens tend to grow faster than similar countries that do not. The same is true of states and regions within this country. Crucially, the income gains tend to come after the education gains. What distinguishes thriving Boston from the other struggling cities of New England? Part of the answer is the relative share of children who graduate from college. The two most affluent immigrant groups in modern America — Asian-Americans and Jews — are also the most educated. In recent decades, as the educational attainment of men has stagnated, so have their wages. The median male worker is roughly as educated as he was 30 years ago and makes roughly the same in hourly pay. The median female worker is far more educated than she was 30 years ago and makes 30 percent more than she did then.

There really is no mystery about why education would be the lifeblood of economic growth. On the most basic level, education helps people figure out how to make objects and accomplish tasks more efficiently. It allows companies to make complex products that the rest of the world wants to buy and thus creates high-wage jobs. Education may not be as tangible as green jobs. But it helps a society leverage every other investment it makes, be it in medicine, transportation or alternative energy. Education — educating more people and educating them better — appears to be the best single bet that a society can make.

Fortunately, we know much more than we did even a decade ago about how education works and doesn’t work. In his book, “Whatever It Takes,” (and in this magazine, where he is an editor), Paul Tough has described some of the most successful schools for poor and minority students. These schools tend to set rigorous standards, keep the students in school longer and create a disciplined, can-do culture. Many of the schools, like several middle schools run by an organization called KIPP, have had terrific results. Students enter with test scores below the national average. They leave on a path to college.

The lessons of KIPP — some of the lessons, at least — also apply to schools that are not so poor. Last year, the Gates Foundation hired an economist named Thomas Kane to oversee a big new push to prepare students for college. Kane is one of the researchers whose work shows that teachers may matter more than anything else. Good teachers tend to receive high marks from parents, colleagues and principals, and they tend to teach their students much more than average teachers. Bad teachers tend to do poorly on all these metrics. The differences are usually apparent after just a couple of years on the job. Yet in a typical school system, both groups receive tenure.

The Obama administration has suggested that education reform is an important goal. The education secretary is Arne Duncan, the former school superintendent in Chicago, who pushed for education changes there based on empirical data. Obama advisers say that the administration plans to use the education money in the stimulus package as leverage. States that reward good teaching and use uniform testing standards — rather than the choose-your-own-yardstick approach of the No Child Left Behind law — may get more money.

But it is still unclear just how much of a push the administration will make. With the financial crisis looming so large, something as sprawling and perennially plagued as education can seem like a sideshow. Given everything else on its agenda, the Obama administration could end up financing a few promising pilot programs without actually changing much. States, for their part, will be cutting education spending to balance their budgets.

A few weeks ago, I drove to Shepherd University in West Virginia to get a glimpse of both the good and bad news for education. Shepherd is the kind of public college that will need to be at the center of any effort to improve higher education. Located in a small town in the Shenandoah Valley, it attracts mostly middle-class students — from the actual middle class, not the upper middle class — and it has a graduation rate of about 35 percent.

Several years ago, the state of West Virginia started a scholarship program, called Promise, in part to lift the graduation rate at places like Shepherd. The program is modeled after those in several Southern states, in which any high-school student with a certain minimum grade-point average (often 3.0) and certain SAT scores gets a hefty scholarship to any state school. When West Virginia officials were designing their program, though, they noticed a flaw with the other programs. The students weren’t required to take a course load that was big enough to let them graduate in four years. In some cases they were required to keep a minimum grade-point average, which encouraged them, perversely, to take fewer courses. Many students drifted along for a few years and then dropped out.

So West Virginia changed the rules. It offered a bigger carrot — free tuition at any public college — but also a stick. Students had to take enough courses each semester so that they could graduate in four years. Judith Scott-Clayton, a young economist who analyzed the program, concluded that it had raised the on-time graduation rate by almost 7 percentage points in a state where many colleges have a graduation rate below 50 percent.

Given those results, the Promise scholarship might seem like an ideal public policy in a deep recession. It pays for school at a time when many families are struggling. It keeps students busy when jobs are hard to come by. It also has the potential to do some long-term good. But nearly everyone I interviewed in West Virginia — the students, the president of Shepherd and other education officials — worried that financing would be reduced soon. The program is expensive, and state revenue is declining. Something has to give.


WHAT STRUCK ME ABOUT the Shepherd students I met was that they didn’t seem to spend much time thinking about the credit requirement. It had become part of their reality. Many college students today assume they will not graduate in four years. Some even refer to themselves as second- or third-years, instead of sophomores or juniors. “It’s just normal all around not to be done in four years,” Chelsea Carter, a Shepherd student, told me. “People don’t push you.” Carter, in fact, introduced herself to me as a third-year. But she is also a Promise scholar, and she said she expected to graduate in four years. Her younger sister, now in her first year in the program at Shepherd, also plans to graduate in four years. For many Promise scholars, graduating on time has become the norm.

Economists don’t talk much about cultural norms. They prefer to emphasize prices, taxes and other incentives. And the transformation of the American economy will depend very much on such incentives: financial aid, Medicare reimbursements, energy prices and marginal tax rates. But it will also depend on forces that aren’t quite so easy to quantify.

Orszag, on his barnstorming tour to talk about the health care system, argued that his fellow economists were making a mistake by paying so little attention to norms. After all, doctors in Minnesota don’t work under a different Medicare system than doctors in New Jersey. But they do act differently.

The norms of the last two decades or so — consume before invest; worry about the short term, not the long term — have been more than just a reflection of the economy. They have also affected the economy. Chief executives have fought for paychecks that their predecessors would have considered obscenely large. Technocrats inside Washington’s regulatory agencies, after listening to their bosses talk endlessly about the dangers of overregulation, made quite sure that they weren’t regulating too much. Financial engineering became a more appealing career track than actual engineering or science. In one of the small gems in their book, Goldin and Katz write that towns and cities with a large elderly population once devoted a higher-than-average share of their taxes to schools. Apparently, age made them see the benefits of education. In recent decades, though, the relationship switched. Older towns spent less than average on schools. You can imagine voters in these places asking themselves, “What’s in it for me?”

By any standard, the Obama administration faces an imposing economic to-do list. It will try to end the financial crisis and recession as quickly as possible, even as it starts work on an agenda that will inspire opposition from a murderers’ row of interest groups: Wall Street, Big Oil, Big Coal, the American Medical Association and teachers’ unions. Some items on the agenda will fail.

But the same was true of the New Deal and the decades after World War II, the period that is obviously the model for the Obama years. Roosevelt and Truman both failed to pass universal health insurance or even a program like Medicare. Yet the successes of those years — Social Security, the highway system, the G.I. Bill, the National Science Foundation, the National Labor Relations Board — had a huge effect on the culture.

The American economy didn’t simply grow rapidly in the late 1940s, 1950s and 1960s. It grew rapidly and gave an increasing share of its bounty to the vast middle class. Middle-class incomes soared during those years, while income growth at the very top of the ladder, which had been so great in the 1920s, slowed down. The effects were too great to be explained by a neat package of policies, just as the last few decades can’t be explained only by education, investment and the like.

When Washington sets out to rewrite the rules for the economy, it can pass new laws and shift money from one program to another. But the effects of those changes are not likely to be merely the obvious ones. The changes can also send signals. They can influence millions of individual decisions — about the schools people attend, the jobs they choose, the medical care they request — and, in the process, reshape the economy.

David Leonhardt is an economics columnist for The Times and a staff writer for the magazine.

Copyright 2009 The New York Times Company

29 January 2009

Shane Oliver's real work

As Zaphod Beeblebrox's shrink noted. "Zaphod's just this guy, you know." Well that might also be said about me, except I am less well known than the

President of the Galaxy. I'll conceed I'm well read, curious and not subject to the herd mentality; as suggested by my total lack of interest in guys kicking

a ball around a field.

In 2007 I was screaming at the TV and laying heavy rants on all and sundry in the hood, they are still barelling up to me these days, with; "Geezes, Kev, you

was right, whadda should I do". I usually reply, "Buy Gold via the Perth Mint Certificate program and switch to allocated when it starts to really ramp" and

generally, worry more about the return of your money and the preservation of its purchasing power than nominal returns implied by glowing phosphors or ink on

paper, no matter how proud and established the letterhead."

Ones gob is smacked by two things, the way the major players and commentators drive via the rear vision mirror, their desperation for a return to "normal" in

"six to twelve months" and the insistance that the worse is past and therefore its "too late to sell."

I'm not going to tell you Shane is wrong, but I suspect he is probably, well, even likely, completely and absolutely dead wrong.

What I will tell you is that he speaks for the pack of finanosaurs that ate the real economy, the dead weight of rentiers and "advisors" and housing loan

cookie cutters who's tunnel vision and greed drove them into an eternal search for trailing commissions and leveraged buyouts with US lines of credit pre

spun into candy floss money.

In mirror filled caves the finanosaurs became so fat with clout that they have survived the impact that blew out the cave and its mirrors and live, for now,

on reserves. They will not survive the comming winter.

As for Shane. He seems a nice guy, but his job is as much one of defending the status quo and keeping you in his game as offering disspassionate views about

actual economic prospects.

Its a shame, Shane, because if the coupon clipers and commish men could face reality they might have a chance of switching paradigms, raising cash and buying

assets down the road dirt cheap with Australian savings, setting themselves and us up for life, if not, as likely, they will be driven to sell at the bottom

like everybody else will be, from your exhaustion and frustration with the fact that they BS'ed you all the way down and the realisation that there is no way


Make up your own mind and don't feed your denial. Hedge your bets, get out of debt and when people throw things at you when you mention stocks and the death

of equities is a headline, buy a little for the kids.

Above all, steer your own course and don't listen to finanosaurs who tell you that asteroids don't strike.

So go back and look at his record since mid 2007 and show me where he has offered you, or the government, or his own sector fearless advice and acurate


I will be pleased to admit I was wrong.

The thing about Depressions is; there depressing...

A colleague contributes...

"Sorry guys, gotta forgive me for the following lenghtly diatribe. While we’re experiencing some disruption in the normal flow that’s typical of BearChat, I thought it might be a good opportunity to share some discussion that I otherwise would not have bothered posting. Keen’s piece is the longest, and I culled that material from a discussion thread with over 150 messages.

I begin with a discussion from Steve Keen’s Debtdeflation blog and, from there, throw in a few other items, all of which have bearing on where we are today and what might be likely scenarios going forward.

I particularly liked the quote from a clinical psychologist in Chicago who said, ”This is really unprecedented. I’ve been practicing for 20 years, and I’m seeing just an unprecedented amount of anxiety, as are most my colleagues”. They call it collateral damage from the economy, a phenomenon that latter generations of Americans seem ill-prepared to cope. An extreme example is the case of the man who killed his wife and children after being fired from a job.

Keen says that, Ultimately, the only way out of this crisis is a still painful route of debt reduction via either inflation (which he doesn’t believe our economic managers know how to create) or legislative debt writedowns. That’s the “bottom line” and makes perfect sense to me. The only thing else that matters is how this “thing” actually plays out.

Keen thinks that attempts to bailout the economy financially have to be given time to fail before more serious measures will finally be considered. Thus, if you buy his arguement, it would indeed appear that we’re in the early innings of what looks like an unfolding painful scenario. Won’t be the end of the world, but for some it will definitely feel like it.

Ballmer Gets “It”, by Steve Keen


Ordinarily I’d simply post a link to a media report in either my Gems or Brickbats page. But this quote from Microsoft CEO Steve Ballmer shows that he really understands what is going on now, in a way that no other person in authority seems to have done as yet.

Ballmer’s perceptive analysis of what is going on is:

“We’re certainly in the midst of a once-in-a-lifetime set of economic conditions. The perspective I would bring is not one of recession. Rather, the economy is resetting to lower level of business and consumer spending based largely on the reduced leverage in economy.”

For consumers, that may mean less discretionary income to spend on....(name your poison - Ballmer was talking 2nd or third computers).

That is precisely what is happening. It is also why, though government action might slow down the decline, ultimately it can’t prevent a serious decline in economic activity. That can happen only gradually as we slowly replace debt-generated spending capacity with income-generated capacity. What the government can do is remove the logjam standing in the way of that process, which is the crippling mountain of debt accumulated by the Ponzi financing behaviour of the last 4 decades (and in particular the last one). But that will require much more drastic action than simply bailouts: given the scale of debt accumulated, either the debt has to be devalued by inflation, or written down via government decree.

We’re still a long way from any government official or politician realising that. But the fact that someone as influential as Ballmer has put his finger on the problem implies that maybe that day of realisation is approaching.

Keen says that, given the scale of the debt we’ve accumulated, and our dependence on growing debt for aggregate demand, that he thinks we’re in for a serious Depression no matter what, and it will be prolonged for as long as governments continue trying to help the private sector validate debt that should never have been issued in the first place.

I expect we’re in for currency collapses galore , and I expect deflation rather than inflation overall. Government’s can’t create inflation simply by increasing fiat money in a debt-encumbered credit-based economy–unless they’re willing to “print” a factor of ten more dollars than they’ve yet done, which I doubt. (When the deleveraging gets up a head of steam, even a deliberate 1% reduction in debt levels would take (multiple) times as much money out of the economy as the...injection pumped into it.)

So he expects we’ll see international finance collapse and debt defaults galore, with cross-border interest rates becoming prohibitive, but domestic nominal rates heading for zero amid collapsing prices and incomes. And, ultimately, the only way out of this crisis is a still painful route of debt reduction via either inflation (which I don’t believe our economic managers know how to create) or legislative debt writedowns. Keen thinks attempts to bailout the economy financially like at present have to be given time to fail before more serious measures will finally be considered.

"I expect the US dollar would plummet. As for its effect on inflation, it might simply wipe out a section of US consumption rather than drive its price all that much higher. Sales of Asian-manufactured consumer goods have already plummeted, even though the US dollar has appreciated largely so far, thus making these goods notionally cheaper. If the dollar’s oil prop were removed and its currency depreciated, sales of these items might evaporate even more. There might be some domestic stimulus in that, but don’t forget that debt dynamics dominate here. Revival via domestic consumption is still a long way off."

The problem with trying monetary means to cause inflation–which Bernanke is doing right now–is that in an overindebted credit-money economy, the increase in fiat-generated money is more than offset by a collapse in credit-created money. That is apparent in the US data right now (though there is still a time lag to be taken into account). As a result, the money supply in toto can fall, even though the government is trying desperately to increase it.

In Japan’s case, even in a country with a high personal savings rate, increased fiat money was completely absorbed into private debt reduction. Japan tried a 30% increase in base money one year, only to see the rate of deflation accelerate the year after.

Minding the Deflation Spiral, by Desmond Lachman


The Fed meets this week amid bad news on labor markets, consumer spending, and industrial production

In the six weeks since the last meeting of the Federal Reserve’s Open Market Committee (FOMC), there has been a further material weakening in the U.S. economy and renewed strains on the U.S. financial system. At the same time, there has been an abrupt weakening in labor market conditions and an unprecedented deceleration in inflation that raises anew concerns about a deflationary spiral.

1. Employment conditions continue to deteriorate rapidly.

2. Labor market and output gaps continue to widen, which must be expected to exert considerable downward pressure on wages and prices.

3. Deteriorating labor market conditions and falling asset prices have contributed to a collapse in consumer confidence to its lowest level in 25 years.

4. Consumer spending, which accounts for around 70 percent of GDP by expenditure, is dropping at its fastest rate since World War II.

5. Industrial production is declining at its fastest pace in 30 years.

6. Housing starts have plumbed new lows, while housing permits suggest no sign of stabilization in the housing market.

7. Over the past three months, consumer prices have decelerated at their fastest pace in the post-war period.

In the context of a significant weakening in the U.S. economy, it is likely the FOMC will make clear in its statement that it considers that inflation risks have further receded, while the downside risks to the economy have increased.

Man kills wife, five kids, himself after being fired


The bodies of five children and two adults -- the children's mother and father -- were found Tuesday in a home in the Los Angeles neighborhood of Wilmington. Among the dead, authorities said, were an 8-year-old girl and two sets of twins -- 5-year-old girls and 2-year-old boys.

Ervin Lupoe apparently called 911 and contacted a television station by fax before committing suicide, authorities said.

Kaiser Permanente said Lupoe and his wife, Ana, were both former employees of the medical center. Both had been terminated, Hayes said, with Lupoe's termination coming last week. It appears there were grounds for the termination, and it did not come as a result of layoffs, he said.

In Lupoe's suicide note, he offered a detailed account of his and his wife's work circumstances, calling the family's situation a "tragic story." He ended it by saying, "So after a horrendous ordeal my wife felt it better to end our lives and why leave our children in someone's else's hands."

Therapists seeing more 'collateral damage' from economy


No formal data exist on the number of Americans who are turning to therapy during the recession, but most clinical psychologists say that referrals are up.

"This is really unprecedented," says Nancy Molitor, a clinical psychologist in Chicago, Illinois. "I've been practicing for 20 years, and I'm seeing just an unprecedented amount of anxiety, as are most of my colleagues."

Rick Weinberg, a clinical psychologist in Tampa, Florida, says that in one recent week 80 percent of his patients were discussing the pain inflicted on them in the economy. His patients included a small business owner who was forced to lay off longtime staff, a family of four evicted from their home and moving into a rental, and a family with two teenagers that was down to a one-parent income and experiencing frequent spending arguments and acting out by the teens.

"I have many patients who come in to see me in such crisis, they haven't opened their bills in three months. They haven't opened their statements. They're not functioning," Molitor says. "We need to really address that in a very quick way to begin to help alleviate their anxiety enough so that they start functioning."

"It's gotten worse. It's absolutely gotten worse. Most people are feeling anxious about money right now," says Bradley Klontz, a clinical psychologist in Hawaii. "When you're struggling with money issues and it affects your ability to carry out your various roles -- if it's keeping you up at night -- I'd say that's when you know it's time."

Beyond elevated anxiety levels, there are concerns about depression and suicide."

"We've had people who are so depressed that they are thinking that maybe life isn't worth going on. It's a small number of people but, you know, that is something that we're becoming more concerned about.”

Oil's going straight back up to new highs

There are 70,000 oilfields in production worldwide; however, the bulk of our production comes from 20 super-giant oilfields, which account for over 25% of daily world production. Of even more concern, the vast majority of these fields were discovered 50–70 years ago.

In addition to the dearth of new discoveries, depletion rates are rising as old fields mature and decline. Remember, newer discoveries over the last two decades have been fewer and smaller, and many of them have been offshore. Smaller oilfields and offshore oilfields deplete at much faster rates than some of the "old giants."

In its latest World Energy Outlook, the International Energy Agency (IEA) estimated that the average observed decline rate worldwide is currently 6.7%, and is projected to increase to 8.6% by 2030. Decline rates for the super-giants are 3.4%, 6.5% for giant oilfields, and 10.4% for large fields. Moreover, natural decline rates (a natural decline rate strips out ongoing investment in new production) are estimated at 9% for post-peak fields. The implication of these large and accelerating decline rates is alarming: "The implications are far-reaching: investment in 1 mbd of additional capacity—equal to the entire capacity of Algeria today—is needed each year by the end of the projection just to offset the projected acceleration in the natural decline rate"

More at Jimbo

28 January 2009

What drives the Gold Price?

This analysis leads us to speculate that while divergences caused by inflationary expectations can last for a very long time, even decades, the long-term price of gold is driven by global money supply.

Eight Structural Factors Undermining Any Turn-Around

by Simon Smelt January 26, 2009

Beyond rescue efforts and hopes of restoring confidence, deep structural forces remain unresolved. Current actions could make matters worse. Consider these eight factors:

First: We are off the map. The U.S. Federal Reserve and Treasury, like their counterparts around the world, face unprecedented challenges. Bank deposits with the Fed, the monetary base, interest rates in the United States and United Kingdom are all at historic highs or lows. Sophisticated tools of economic management are deployed, yet there is no sign that financial leaders have found maps to guide them beyond the immediate need for survival. They can’t even agree the cause: was it a global savings glut (former Treasury Secretary Henry Paulson) or bankers’ behavior (former Fed Chairman Alan Greenspan). They just want to get out of the hole quick. Little is heard of how to tackle America’s empire of debt.

Second: The compass is gone. The focus of monetary policy around the world has been keeping inflation (as measured by the Consumer Price Index) under control and, subject to that, encouraging economic activity through low interest rates. But, this assumes that: (1) The market – guided by light-handed regulation – would look after the rest, notably risk; and (2) prices not covered by CPI – such as asset prices – didn’t matter much for the purposes of monetary management.

Well, wrong on both counts. Result: there are no clear, long-term policy settings for central banks to follow. This makes life unpredictable – just what markets don’t like.

Third: The transmission and steering are shot. The stimulus of competition and the market is being weakened by the growing role of government. More lobbying and more rescue packages will weaken economic performance.

Unlike other central banks, the Fed is not part of government, yet it is a key player. At international level, the elaborate Basle II accord to regulate banking has proved ineffective because it does not catch securitisation.

Fourth: The engine room has throttled back. The engine for global growth has been the U.S. consumer. This stems not from real wage growth but from the availability of cheap credit and the wealth effects of asset price inflation. Growth of 12% plus per annum in household borrowing is unsustainable. Consumption will stay shut down because of reduction in both the supply of credit (factor five) and the demand for credit.

U.S. households have consistently grown their wealth by 3% per annum, compounded, in the medium to long term. In the last 20 years, this has been achieved through capital gains not savings – boosting consumption and encouraging borrowing. The 2008 shock removes those gains. Households will save more, lowering consumption. A return to previous savings rates would result in a $1 trillion per annum decline in U.S. gross domestic product (GDP).

Fifth: The fuel supply is low. Much has been written about the reduced availability of credit. The government and Fed are stepping in to fill the gap in various ways. But:

Sixth: The tugboat can’t do it. There are three big problems.

First, government’s operational limits. In the United States, government accounts for 20% of GDP. The harsh transition to a post bubble world is putting pressure on government to expand to replicate the size or pattern of lost economic activity or to enforce spending and lending; e.g. coercing banks to lend more, regulating old cars off the road so as to speed the replacement cycle for cars, and so on.

Second, monetary policy carries dangers. With reduced leverage by banks and reduced consumption by households, both the quantity of money and the velocity of its circulation will fall. This shrinks nominal GDP. For the Fed’s monetary levers to precisely counterbalance this fall is impossible. If the Fed undershoots, this leads to deflation and recession. Fed Chairman Ben Bernanke will err towards overshoot but the resulting inflation will be difficult to control.

Third, U.S. government debt is climbing, whilst reduced economic growth makes it harder to absorb consequent claims on future revenue. Increased borrowing by government is a burden on future generations of taxpayers.

These three problems show that the boundaries for government action will be pushed hard. However great a leader new President Barack Obama may be, the U.S. government cannot fulfil its long to-do list from the downturn, and repay increasing borrowings, and meet its growing future obligations and ensure a healthy and competitive economy. Yet, political as well as borrowing pressures encourage it to try.

Seventh: Confused signals. Taxpayer funded bailouts seek to save businesses, avoid outright nationalization and forestall panic exit of remaining private capital.

But, in consequence, government’s role has grown from providing welfare insurance to financial insurance. A net transfer from the prudent to the imprudent and from future generations to this is enforced. Consequences of mistakes are borne by those who did not make them.

The signals are perverse and reinforced by leaders. In a guilt free society, Paulson and Treasury Secretary-designate Timothy Geithner view greedy and unwise U.S. consumers and bankers as victims of Asian lenders: “China made me do it!”

Eighth: Stormy international waters. The United States is the world’s main debtor and its dollars provide liquidity to global trade. Eighty-five percent of international trade is in the world’s reserve currency – the U.S. dollar. Foreigners buy 80% of U.S. Treasury bills. To keep its factories churning, China and other exporters buy U.S. dollars – effectively providing goods on credit. All this is of vast benefit to the United States but could change.

The tipping point may come in 2010 from the mundane issuance of government bonds. New government spending programs and the downturn in tax revenues will require many governments massively to expand bond issues to cover their debt.

This will mean: (1.) Downward pressure on bond prices (higher yields), and (2) sufficient supply of non U.S. government bonds that big money can shift from U.S. assets. A lot of parked investment money will be looking for a good home. How much more exposure to U.S. debt – and “victim” psychology – will investors want?

These eight factors are a formidable combination to overcome. Lifeboats anybody?

Simon Smelt is a New Zealand-based economist and policy analyst.

UK versus US ~Prudent Bear Fund

The U.K. is in trouble. Today it was reported that the British economy contracted a much worst-than-expected 1.5% during the fourth quarter (not annualized!), the steepest economic decline since the dark days of 1980. Manufacturing activity sank a dismal 4.6%, while services contracted by 1%. Some forecasts now have the British economy this year suffering the most severe economic contraction since 1946. There’s now a strong case for using “depression” when describing this deepening financial and economic malaise.

The pound today traded at the lowest level against the dollar since 1985. This currency has depreciated 30% against the dollar over the past 12 months. Against the yen, the pound has collapsed 42% during the past a year. There is little room left for conventional monetary policy. At 1.50%, the Bank of England’s (BofE) base lending rate is today at the lowest level since 1694.

Curiously, the British pound has declined 6.5% against the dollar so far this month, while the dollar index has gained about 6%. I say “curiously,” as I would argue that in key aspects of financial and economic structuring, the U.K. provides a microcosm of our own systemic vulnerabilities. In a recent Bloomberg interview, Jim Rogers stated “The pound sterling is going to be under pressure. The U.K hasn’t got much to sell the world anymore.” His comments to the Financial Times were even harsher: “I don’t think there is a sound U.K. bank now, at least, if there is one I don’t know about it… The City of London is finished, the financial centre of the world is moving east. All the money is in Asia. Why would it go back to the west? You don’t need London.”

Following our direction, the U.K. over the past decade gutted their already shrunken manufacturing base as it shifted headlong into “services” and finance. While this finance and asset inflation-driven Bubble economy seemed to work miraculously during the boom, the post-Bubble reality is a severely impaired financial system and an economic structure incapable of sufficient real wealth creation.

I feel for British policymakers. Just five short quarters ago, overheated nominal GDP was expanding at about a 6% pace. And with inflation surging to the 5% level, the Bank of England pushed its base lending rate to 5.75% (summer of ’07). I’ll give the BofE Credit for trying to tighten financial conditions. It was, however, in vain, as Acute Global Monetary Disorder overwhelmed domestic policymaking. BofE tightening only widened interest-rate differentials, especially compared to near zero borrowing rates in Japan. Finance inundated the City of London in a finale of unwieldy speculative excess, setting the stage for a reversal of flows, de-leveraging and today’s collapse.

Yesterday, U.S. insurance company Aflac dropped 37% on concerns for its exposure to European “hybrid” securities - in particular preferred-type instruments issued by the large U.K. banks. According to research by Morgan Stanley (Nigel Dally), “When it comes to capital adequacy and investment portfolio strength, Aflac has historically been viewed as the gold standard across the industry.” Accordingly, the Street responded violently to the report highlighting the company’s potentially significant exposure to securities that have suffered huge losses in market value (Aflac rallied sharply today). According to the Morgan Stanley report, some of the hybrid securities issued by U.K. lenders Royal Bank of Scotland (RBS), HBOS, and Barclays are now trading at between 15 and 45 cents on the dollar.

Not long ago during the boom’s heyday, these types of securities were viewed as low risk instruments. They were, after all, issued by major – and at the time well-capitalized –banking institutions. In the worst-case scenario, these institutions (and their hybrid securities) were viewed as too big to fail. In reality, these banks were issuing a most dangerous class of securities - higher yielding (“money-like”) instruments appealing to even the more conservative investors. Today, the entire U.K. banking system is enveloped in a vicious downward spiral. Tens of billions of securities that only a short time ago were perceived as safe are being heavily discounted for the possibility the issuing institution will be “nationalized.”

On Wednesday, troubled Royal Bank of Scotland promised to lend $8.7bn in exchange for various lines of government support. The market took the news as a huge leap toward nationalization and governmental control over the U.K. banking sector. Even RBS’s CEO was quoted as saying, “We’ll be one the first guinea pigs.” The markets now view that U.K. policymakers will have few available options other than borrowing hundreds of billions to recapitalize their banks and support the securities markets.

Ten-year government “gilt” yields spiked 29 basis points higher this week to 3.68%, with a 2-wk gain of 55 bps. On Tuesday, Britain reported a $20.5bn (14.9bn pounds) fiscal deficit for the month of December. Spending was up 6%, while tax receipts were down 5.5%. The European Commission is now forecasting the U.K. deficit to surpass 8% of GDP this year. After trading at about 20 bps this past June, the cost of U.K. Credit default swap protection has spiked to 147 bps (traded as high as 165bps Wednesday).

The U.K. gilt market seemed to lead global bond rates higher this week. As the scope of global financial sector capital shortfalls and forthcoming economic stimulus become clearer, bond market nervousness grows. U.S. 10-year yields ended the week 31 bps higher at 2.59%, about 110 bps below comparable gilts. There should be little doubt that our new Administration will move quickly and decisively to try to bolster the financial sector and stabilize the real economy.

I fully expect our Post-Bubble Financial and Economic Predicament to parallel that of Britain. At some point, our problems will likely be of much greater scope due to, among other things, our system’s larger size. So far, the U.K. has suffered a more acute crisis due to its inability to stabilize its troubled financial sector. For one, it is suffering through a more destabilizing outflow of speculative finance (unwind of carry trades). Also, the U.K. financial structure has traditionally been less government-influenced – leaving it today more vulnerable to a crisis of confidence. Outside of government debt instruments, confidence has faltered for large cross-sections of U.K.’s financial claims (“moneyness” has been lost).

Our system has to this point proved relatively more stable due primarily, I believe, to the instrumental role played by government and quasi-government institutions such as the FHA, Fannie, Freddie and the Federal Home Loan Banks. The market’s perception of “moneyness” is retained for multi-Trillions of U.S. claims – a dynamic that bolsters the view that the U.S. dollar retains its “reserve currency” and safe-haven status. And as long as this confidence holds, faith in the government’s capacity for system “reflation” endures. But it all has the look of a fragile confidence game, and I fully expect the invaluable attribute of “moneyness” to be tested at some point.

There is absolutely no doubt that a massive inflation of U.S. financial claims is in the offing. One would suspect it is only a matter of when market perceptions of “moneyness” adjust. This week’s jump in gilt yields could portend a troubling new phase in the U.K. financial crisis. It could also be a harbinger of a more general crisis of confidence for global currencies and debt markets. The long-bond suffered its worst week since 1987 (according to Bloomberg). Gold was up $43 today and $56 for the week.